Dollar cost averaging is a key strategy for successful long-term investing. It’s also the lazy way to invest because for it to be effective you’re required to sit back and do almost nothing. Potentially it can also provide better long-term returns than constantly watching the markets for the best time to buy and sell.
All you need to do is invest a set dollar amount regularly (including re-investing dividends and distributions), regardless of market conditions. Investing through a unit trust is usually the easiest way to do this, but the same principle can be applied to direct share investing.
How can this be?
Dollar cost averaging is effective because, when unit or share prices are down, your set investment buys more, and when the market is up these units or shares are worth more. So at the end of your long-term investment period, you generally end up with a greater accumulated dollar value.
This strategy can still lose money when prices fall steadily, especially if you are forced to sell. On the flip side, dollar cost averaging generally loses less value than a lump sum strategy in these conditions. Also bear in mind that in times when market prices trend upwards, investing a lump sum could be a better strategy.
Dollar cost averaging in action
Assume you invest $200 per month in a unit trust over a five-month period. In this example, the unit price drops from $10 to $5, before returning to $10 at the end of the fifth month. As you can see below, investing a total of $1,000 over the five months in this example allows you to buy 140 units. At the end of the period these units are worth $1,400 – a profit of $400.
Average price paid = $7.14 (ie $1,000/140 units). Investment value at the end of five months = $1,400 (ie 140 units at $10each)
- Select sound investments with growth potential
- Monitor investments to make sure they remain sound
- Invest a fixed sum at regular intervals (eg $200 per month or $1,000 per quarter)
- Don’t panic or respond to short-term market fluctuations
- Seek appropriate advice to help make sound decisions